Anytime a privately-held company issues securities – to investors in a financing, to employees as compensation, or for any other reason – the issuer must be able to point to an applicable exemption from the general requirement that all issuances of securities be registered with the Securities and Exchange Commission (SEC). When raising capital from outside investors, be they friends, family, angels or venture capitalists, privately-held companies most often rely on one of the three exemptions found in Regulation D, which encompasses Rules 501-508 promulgated under the Securities Act of 1933.
The three exemptions from registration encompassed by Regulation D are found in Rules 504, 505 and 506, while the remainder of the rules in Regulation D set forth further limitations applicable to offers and sales of securities pursuant to each of the three exemptions (we plan to delve into some of these limitations at a later date). The most important aspects of each exemption are summarized below, but please note that the summaries do not purport to cover all aspects of Rules 504, 505 and 506, and should not be considered legal advice. Legal counsel should always be consulted in advance of an issuance of securities.
Rule 504: Rule 504 offers a broad exemption from federal registration for offerings of not more than $1 million over a 12-month period. Unlike Rules 505 and 506, Rule 504 does not impose any restrictions on the use of general advertising and solicitation to promote the offering, or the number or sophistication of investors, and the issuer is not required to provide any disclosure materials regarding the offering to potential investors (though it is often advisable to do so). Securities offerings made under Rule 504 remain subject to state securities laws (also referred to as “Blue Sky” laws), which may impose additional restrictions and requirements. Issuers relying on Rule 504 must either register or qualify for an exemption from registration in each state in which securities are offered.
Rule 505: Rule 505 permits an issuer to offer and sell up to $5 million of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. The issuer must furnish detailed information about the company’s business and finances to non-accredited investors, as required by Rule 502(b)(2). Rule 505 also prohibits the use of general advertising or solicitation to promote the offering; either the issuer or an agent of the issuer (officer, director, employee or intermediary such as a placement agent) must have had a “substantive and pre-existing relationship” with any prospective investor. As with Rule 504, Rule 505 offerings are subject to state Blue Sky laws, which may impose additional restrictions and requirements and must be considered on a state-by-state basis.
Rule 506: Rule 506 permits an issuer to offer and sell an unlimited amount of securities to an unlimited number of accredited investors and up to 35 non-accredited investors, but unlike offerings under Rule 505, any non-accredited investor must have “such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.” As with offerings under Rule 505, in a Rule 506 offering the issuer must furnish non-accredited investors with detailed information about the company’s business and finances (required by Rule 502(b)(2)) and the Issuer is prohibited from using general advertising or solicitation to promote the offering. Unlike offerings under Rules 504 and 505, however, offerings that meet the requirements of Rule 506 are exempt from state Blue Sky laws pursuant to the National Securities Markets Improvements Act of 1996, though states may still require issuers to provide notice of the offering to state securities regulators.
Tags: Accredited Investors, Angel, family, Financing, founders, friends, investors, PPM, Private Financing, Regulation D, restricted stock, Rule 504, Rule 505, Rule 506, securities, Seed, Valuation, VC
Tags: Accredited Investors, Angel, family, Financing, founders, friends, investors, PPM, Private Financing, Regulation D, restricted stock, Rule 504, Rule 505, Rule 506, securities, Seed, Valuation, VC